Pension Tax Relief

The government spends considerable amounts of time devising schemes that will encourage individuals to save money in personal or company pension schemes. It is generally accepted that on its own, the State Pension is not sufficient as a single source of income, and so the government is attempting to make personal and company pension schemes as enticing as possible.

Tax breaks are the key incentives that a government can offer. The Exchequer's pension 'tax relief' scheme offers a lower tax bill on contributions made to Personal Pension or company pension funds. The way in which the tax relief system will work for you depends on what type of pension scheme you are paying into.

Company Pensions

If you are making contributions to a company pension scheme, it is highly likely that your contributions will be deducted automatically before you even see your wage packet. Tax deductions are also made in the same way, using the PAYE System. Pension contributions, however, are deducted before your tax is calculated, ensuring that these contributions remain tax-free. This means that you will almost certainly be required to take no action whatsoever in order to ensure either that your contributions are made on time, or that they are as tax-efficient as possible.

Personal Pensions

If you are making contributions to a personal pension scheme and you are a basic rate taxpayer, the responsibility for claiming tax relief rests with your pension provider. They will claim the tax back from the relevant tax office, and it will automatically be added to your pension fund. If, on the other hand, you are a higher rate taxpayer, you will be required to make your own claim for tax relief through Self Assessment.

There are various other ways in which pensions have been made highly tax-efficient. Perhaps the most widely cited of these is the right of the pension-holder to withdraw a lump sum equal to 25% of the total fund on maturity. It should be noted, however, that the tax-free status of this lump sum only applies to a lifetime allowance of £1.8 million (this figure is for the tax year 2011-12, but from 6th April 2012 it will be £1.5 million). You would, however, have to have a considerable total fund in order to exceed this threshold. Furthermore, you should remember that pensions are not subject to capital gains or investment income. This is particularly useful for those whose pensions are linked to the stock markets or make use of other such investment vehicles.

There are limits on the amount of tax relief that you can claim, but these are not relevant for the majority of individuals as they are very high. The key fact to remember is that the maximum amount of relief to which you are entitled is equal to 100% of all your earnings for that tax year. Similarly, although you can contribute to as many pension schemes as you wish, you can only make contributions up to a maximum annual amount, set at £50,000 for the 2013-14 tax year. For the 2014-2015 tax year the amount will be reduced to £40,000. Contributions made above this limit will be subject to tax at 40%. As you can see, you would have to be a very enthusiastic saver in order to exceed either of these thresholds.